Miraculous failure

This is Britain's third major recession since 1970. It has been the longest post war recession so far. In 1991 the economy contracted by 2.2 percent and in 1992 by 0.6 percent. Although the recession is officially over, the best estimates of current growth are well below the estimated optimal growth of about 2.5 percent per annum, so there is still a 'growth recession'.

After every recession since 1970 unemployment has bottomed out at much higher levels than before. One estimate says that unemployment will not fall below around 2.5 million, and that is on the government's fiddled figures.

The Tories blame Britain's economic difficulties on the world economic recession. In fact, amongst the advanced industrialised economies Britain and the US were first into recession in 1990. The temporary economic boom generated in the rest of the EC by German unification helped to offset the depths the recession reached here. The recession in the rest of the EC is now threatening to limit economic recovery in Britain.

Britain's economy has particular problems caused by government economic policy and partly reflecting Thatcher's failure to reverse long term weaknesses.

The Lawson boom, a period of high but unsustainable growth which gave rise to the talk of an economic miracle, preceded the recession. It was caused by tax cuts for the rich, the deregulation of the financial sector leading to an explosion of credit, and interest rates kept deliberately low after the stock market crash in October 1987. The result was rising inflation and a ballooning balance of payments deficit--the excess of imports over exports. To attract funds to finance the surplus of imports over exports interest rates doubled between 1988 and 1989.

Underlying these factors was the failure of the Thatcher government to reverse the relative decline in manufacturing industry. Between 1979 and 1987 manufacturing output rose by 67 percent in Japan and manufacturing employment by 7 percent. In the UK output grew by 0 percent and manufacturing employment fell by 27 percent in the same period.

In the recession of 1979-81 British manufacturing industry suffered even more than during the 1930s: manufacturing fell by as much as 19.6 percent. Between one fifth and one quarter of the manufacturing sector's equipment and capacity were destroyed and 1.7 million jobs were lost.

Net investment into manufacturing industry between 1979 and 1990 was virtually zero. On the other hand there was an explosion of investment in financial services. The share of investment in plant and machinery that went to financial services rose from 11.7 percent to 29.4 percent which in turn reflected a more than threefold volume increase.

Lack of manufacturing capacity meant the Lawson boom was bound to be choked off by rising inflation and a balance of payments deficit. It also means any economic recovery based on a boost to domestic spending will be limited by the same problems, particularly a burgeoning payments deficit. Uniquely the economy was still running a deficit of £12 billion in the very depths of the recession.

British membership of the Exchange Rate Mechanism of the European Monetary System made the recession worse. Britain entered in autumn 1990 to reassure the financial markets of the government's anti-inflationary resolve. But the exchange rate was too high, depressing exports. German inflation led to the collapse of the East German economy, an upsurge in government borrowing to try to prop it up, higher inflation and much higher German interest rates. This meant British interest rates had to stay even higher to peg the pound to the Deutschmark. Very high real interest rates prolonged the recession.

The feeble recovery of the economy is largely attributable to yet another failure of government economic policy--the collapse of British membership of the ERM on 'Black Wednesday' in September 1992. The pound fell in value boosting export competitiveness, and interest rates fell relieving some of the burden of debt in the economy.

It would have been a miracle if Britain leaving the ERM had not boosted the economy to some degree. However the economy is still weighed down by high levels of personal and corporate debt built up in the 1980s. A sustained consumer led recovery seems unlikely in the near future. And if it came, lack of manufacturing capacity in Britain would threaten an unsustainable balance of payments deficit.

The government is clearly hoping for an export led recovery, but 60 percent of exports now go to the EC. The EC is hitting the depths of recession with manufacturing output collapsing and unemployment set to exceed 20 million.

Japan is also now suffering severe financial and economic contraction. Britain attracted 50 percent of Japanese inward investment into the EC in the 1980s--the one manufacturing investment bright spot for the government. This external boost to the British economy is unlikely to resume for the foreseeable future.

On top of everything else the government is struggling with a huge budget deficit--the gap between government spending and revenues--which is likely to top £50 billion this financial year. This is higher than every other G7 country except Italy.

The budget deficit is the product of tax cuts for the rich, the length and depth of the recession which has cut income from taxes and boosted social security payments, and the more general flair the Tories have had in slashing spending.

The government is pledged to cut spending and raise taxes to reduce the budget deficit. But these could backfire if they choke off recovery, as slower or even negative growth will simply increase the budget deficit.

With the exception of the Japanese stock market which has more than halved in value and shows no sign of recovery, major stock markets have been rising quite strongly in recent months. The two principal reasons for this are falling interest rates and the hope of economic recovery. The US market has reached values last seen just before the crash of 1987. But stock markets have begun to look much shakier. In the US interest rates are on the turn as fears of inflation rise and because there are insufficient savings to meet government deficits in the US and elsewhere. More acute financial instability is a strong possibility.